Apart from my characteristically purple prose - people have said the other posts are hard to grasp without a glossary explaining acronyms and terms. The following is "how I am using the terms" in my thinking/discussion not necessary dictionary.com or FCA approved. See below:
Glossary and narrative
Annuity – old fashioned once mandatory way to draw a pension by buying one. Transfer the funds to an insurance company. They invest in a regulated manner – which includes a lot of gilts/bonds as a pool. They promise an income largely based on long term gilt rates to you, or plus a partner at 50% / 100% (called a joint life), perhaps even inflation indexed in some way e.g. 3% or not, more for the sick and for smokers who die sooner. Rates have been terrible and getting worse for years but have come up a bit now from all time lows. There is a very low risk of variability of income (from total insurance company failure + limits to the regulated protection). But if you remember the 1970’s people on fixed incomes (non-indexed annuities being an example of this) were totally destroyed by inflation. So while even a 3% indexation cripples the annuity rate offered horribly it does not protect against a 1970’s style scenario just a continuation of “normal” CPI. Web based rate tables are accessible for income rates per £100k of purchase. This is what can be done with gilts/bonds while making a profit and taking the early deaths to pay for the long lived (risk pooling). The inflation situation leads to one possible argument in favour or not buying one and staying invested in drawdown – this is that the nominal value of investments in assets better floats along with inflation (or currency depreciation) even as the real value of the fiat £ is inflated down or loses FX value. Drawdown discussion on the role of annuities tends to be around how much “guaranteed income” is desirable in a long term budget and whether it is worth buying an annuity later on in retirement (when rates become better due to age 75+) to get rid of the excess longevity risk. I have no clear position on this one. It is more of a concern if your assumptions on “not running out” start to look iffy.
Bonds – used loosely in my notes to mean debt or fixed income instruments as investments as in “funds of bonds” or individual bonds and gilts (government issued bonds). Most of the time the pensions discussions about these is about “how many to have” in a diversified portfolio with a yield which either offers a real return or at least an offset against loss of value to inflation vs a straight forward holding of cash. Traditional pre-annuity purchase thinking would be to hold near 100% as retirement date approaches to avoid a last minute market correction knocking down the value just ahead of the one time purchase. The same concept applies to a lesser degree to the access to tax free cash (i.e. 25%). If this is not accessible when needed (as opposed to just wanted) then a lot of equities might need to be sold just after a crash to pull it out. Which has a long term bad effect on income in retirement. A lot of occupational pension funds “pound cost average” the sales of equities to buy bonds over a long period to switch you over. Drawdown complicates the picture on bond desirability as there is no one off annuity purchase at 55/65 so staying invested in something higher risk and potentially higher yield could be a lot better. Requires that you believe there is an equity premium (future resembles past) and can handle the risk and equity volatility in your overall drawdown plan and chosen approach to buffering. The other discussion on bonds beyond “cash” buffer in drawdown looks at holding a ladder of bonds to their maturity. Building a DIY annuity. As an example buying a 5 year bond at 2% yield locks in a cash flow for the future to turn up when wanted in drawdown (5 years out). Some income (yield) meanwhile. Purchased at a market price (which may be a bit different to the redemption “par” price. Held to maturity and then redeemed at par. A stack of these 188.8.131.52.10+ years long out etc. Any capital loss happens upfront. There is a known income stream and a known par value. Drawn and consumed as they turn back into cash. Further trading optional. A “Bond ladder” is built out of different maturities to create the desired cashflow shape out of the real yields (if there are any) and the redemptions. This is DIY “annuity” in that it is invested similarly but you retain the capital yourself (only relevant if you die young) and the longevity risk (there is no pooling with others on the living too long risk) but you can still remove most of the market risk apart from counterparty risk (corporate failures or government defaults). You don’t care what happens to the bond prices particularly e.g. due to interest rates rising as you don’t sell them but redeem at the end.
I anyway find the correlation of bonds/equities in a global correction or another heir to 2008 style crisis a bit suspect. I find bond funds (as opposed to ladders) a problematic topic at present with a potential – negative price outlook for these holdings as interest rates eventually stagger off the floor. Yields are of course rubbish due to low interest rates. Apart from the category of lending to the people who are least likely to give it back (i.e. junk bonds). My current view (as a fairly inexperienced investor is that you are probably better off with P2P (diversified across platforms) outside a pension wrapper if you want to get into that personal and small business lending space. I don’t want to anyway. The people trying to rip you off in corporate junk bond land are more sophisticated and so best avoided (companies themselves and the bond sales intermediaries).
CAPE – Cyclically Adjusted Price Earnings ratio - long term comparison metric on equity valuations and how much optimism about the future is priced into a given market level. Simply do markets “look” expensive or cheap vs historic norms. Is used as a metric in some schemes to manage and adjust either investments or extraction technique and amount - how much to take.
DC / DC Pot – Defined Contribution a.k.a. Money Purchase. A pension scheme where you save a “pot” of money rather than build up an entitlement to an income stream represented as a % of a salary (final or average). Most pensions are the DC kind now where the individual needs to decide ont the investment strategy both while they save and now post pension freedom also while they draw. This whole research project being about the 2nd part with a UK regulatory focus.
Drawdown – This was introduced as an alternative to annuity purchase a while back and for a while it was quite constrained on what you could do with annuity comparisons built into the process. G Osborne ditched all that and opened up what people now talk about as “pensions freedom”. There is a load of regulation about how drawdown is operated, how much tax may be due and when. There is a snowstorm of acronyms – LTA BCE PCLS UFPLS. If going this route there is a need to understand the taxation basics and how pensions work – the options and inheritance rules that have at different times changed at 75, 85, on upon death etc. Rules which will likely change again. I would recommend getting to grips with the web advisor support material from the big companies and the HMRC web documents so you understand this acronym soup - even if you are going to an advisor. The conversation will go better and be more useful. If you google you will find a lot of older material still up that is just wrong due to the rules changing. Key things:
ERN - Early Retirement Now – a US blog focused on the saving to become free of the need for regular employment and go portfolio / gig based / early retired in 30s-40s. A lot of the “how to run a pension” from 55-95 (forty years) is even more extreme if you add another 20 years. Hence the strong focus on “how much is needed” fund as multiplier of target income – 25x – 33x etc. – “long term sustainable investment” and “country specific tax planning”. I have found the ERN safe withdraw rate series a useful introduction although I bought the McClung book Living off your Money thereafter. This series is about the so called “4% rule” being debated and back tested along with alternatives to assess what is safe the max to take and not run out before you die. ERN is not entirely reliable – sometimes he simplifies and trashes someone else’s proposal but his test is not complete because it doesn’t implement the original scheme properly i.e. he has debunked something “similar to” rather than the actual proposal. A pinch of salt needed. Or you use the open source tools FireSim FireCalc etc. to run your own “back tests”. If you are handy with MonteCarlo simulation software then run your own random walk simulations. I am not putting in the time to do this as I don’t feel a need to run my own math. Historic market data sets used being key anyway. I would rather do a quick literature survey and draw some tentative conclusions on “good enough” and then test any specific more tricky personal planning pieces and IFA proposals against it.
ETF – Exchange Traded Fund – Different way of holding underlying equity assets and other more complex investment positions – volatility index funds, leveraged 2x 3x funds which zoom in one or another direction as something more pedestrian moves. Read the Fecking Manual (RTFM) for the more complex ones. Different risks (e.g. derivatives counterparty) to holding simple assets via a nominee account + custodian etc. Basic ones may be a cheap or great or tax/cost advantaged way to do it. So either highly sensible or insanely dangerous in a pensions context. Tread carefully. Clearly if you are an investment professional then there are ways to use options puts, gets and LEAPs to attempt to “insure” a portfolio by putting a cap on gains and a floor (all subject to counterparty risk) on losses. This looks a bit intimidating to me for the retail investor in retirement who is thinking about they will operate it at 85 or their spouse doing so at similar age. Your mileage may vary.
FCA – Financial Conduct Authority – one of the main financial regulators of interest in this space – of IFA’s, of the pension operator “rules”. Currently studying the early impact of pension freedom on consumer behaviour and assessing what needs tweaking to protect the vulnerable.
Global Equities – Used here as short hand for “all equities everywhere” – In the passive case at geographic market weightings. Geographic diversification and a relatively small exposure to emerging markets unless you skew it away from market weights. This usually involves roughly 50% USA stuff which can be viewed as useful diversification (from an excessive UK focus in the era of Brexit) or as a drawback (Buying US stocks in the era of Trump trade wars). As examples in my old employer scheme there are global equity funds and global ethical FTSE4Good global trackers (without the “sin” stocks). As it goes - I recently switched from a UK all stock posture to global ethical as an insurance on a UK specific negative reaction to a possible volatile Brexit. Nothing has happened yet and the UK FTSE Allshare and the Global trackers are still broadly tracking. We shall see. Who knows. FTSE 100 is obviously boosted by sterling dipping due to overseas earnings FX. A more difficult Brexit could fuck up UK 250/small cap at least temporarily.
IFA – Independent Financial Advisor. A regulated provider of financial advice. FCA registered. Normally insured due to lifetime liability for bad advice (but not for poor investment outcomes). Does this stuff for a living. Various exams and certs exist. However their living comes from a ~0.5% rain or shine rake of your pot each year as well as pension platform fees, investment fund fees etc. Argument boils down to this. It’s worth it if they make you more by guiding you to good choices, the process, appropriate (to risk appetite) investments, tax strategy etc.; can keep your investment detail averse spouse going smoothly if you die first. Regulated protection and personal trust are super important. Sadly as in all of life some are cynical and provide precious little vs the fee. Some (fake or unregistered usually) are the full criminal rogues. Pot size is a huge factor. Clearly there is little incentive for them to work with small pots. Same amount of per customer compliance risk, for a fraction of the income. Their costs due to their insurance going up are under pressure due to the regulator taking an overly strict “customer can be a wilful idiot and it’s still the advisor’s fault despite issuing the specified regulated paperwork approach”. The other issue that bugs me about the IFA topic is that the space for “fee drag” is anyway so tight. Example - if you took an arbitrary fairly high 7% as a long term portfolio yield (on a blend of stocks and bonds and cash (buffer)) and took 3% for inflation. In that fagpacket there is a real 4% to “share”. 0.5% to a platform. 0.5% to the advisor, maybe 0.25% to a fund (neither a cheap nor expensive example – some are 0.05% others are 0.5%. So 1.25% of 4% is gone in fee drag – each and every year. 2.75% for you topped off by any trajectory you place on selling down the fund towards zero at age 95 or age of choice. If you get rid of the IFA then there is a certain 0.5% x 40 years straight away. Advisors absolutely need to be paid for their professional advice/risk. But many believe that this is this too much of the available yield cumulatively over 40 years. Hence the rise of self managed investment. I am not a fan of giving 20% of an initial DC initial pot over 40 years for a brief annual investment review carried out by an intern on a cloud application and some fairly generic compliance letters. Caricature – the service *may* be much better than that. For advice on complex or specific tax issues or at setup then I get the point. It is possible to get specific fee based advice but they don’t much like it – funds under management is a much more profitable way to work a.k.a. Wealth Management. The industry is busily lobbying the regulator and politicians to make opting out as difficult as possible or impossible. Trebles all round.
IHT - Inheritance Tax
ISA – Individual Savings Account. Tax advantaged savings account. In pensions discussion one option for handling tax free cash is to take it and push it back into ISA’s invested in stocks again - £20k pa or £40k pa with spouse transfers. It is then under your control and any future pensions rules changes can be ignored for that portion i.e. 25%. If you think that a) you will spend it so IHT estate is irrelevant b) a future git of a chancellor may revoke the option for tax free cash access then this seems a bit of a no brainer at 55 but no earlier as illegal in almost all cases. The only real downsides are a) inside estate (current rules) where pension is treated differently b) potentially costs for additional investment platform (this depends upon whether you want lowest cost at risk of all eggs single basket or have used more than one pot on more than one platform. Risk that future chancellor targets ISAs
PCLS – Pension Commencement Lump Sum (Colloquially “tax free cash”). Currently you can take 25% of your personal LTA (1m as standard) i.e. 250k from your pension in a lump with no taxes. One off at start of retirement. If you have a higher personal protected LTA then limit is 25% of that. Husband and wife team would take ~4-5 years to get this fully back inside an ISA assuming some is spent/consumed. You can also get this tax allowance working a different way “as you go” taking income. Which of these is better will depend upon your circumstances, consumption plans and your cynical views on likely future government action and propensity to change the rules for ISAs, Pensions etc. I tend to the view that being in more different schemes is better to mitigate political risk. Pensions have been fiddled with relentlessly.
Platform Fees – the money charged by Hargreaves Lansdown or Vanguard (from 2018) or others to operate a SIPP (pension investment pot) for you. Platforms which support Drawdown being of interest as there is no point in leaving an employer scheme in good health with good protection unless you need something – investment choices or drawdown mechanics. Many employer occupational schemes such as mine (ARSP) do not support drawdown so you need to “transfer out” to a SIPP or a different employer or personal pension which does support it. This is a minefield. Scheme types have different levels of regulation protection – employer schemes often better than SIPPs. Existing terms make transfer out a no no for some people due to valuable “old” guarantees on annuity rates or investment returns, death benefits etc. (This was not the case generally with modern DC schemes like ARSP which is the scheme I am familiar with).
SIPP – Self invested Personal Pension. DC pot – self managed typically these days on an online platform with telephone or written fall back channels.
KISS – Keep in Simple Stupid
High Yield Portfolio – This is used here as short hand for a form of individual stock picking. Some people like to build a portfolio of long term “good dividend payers + increasers” and weed out the fragile companies and hold this portfolio of yield generators directly rather than via an “income fund” (semi-passive or actively managed for a fee). The data is available. You are instantly ahead by the fund fees % (not a lot 0.1% – 0.25%) you pay platform and trading fees only). But you concentrate your risk of failure and capital loss onto this short “list” of stocks and will need to keep on top of it every year or two. Clearly not the answer for the whole of a DC pension pot but perhaps a valid option for a part of it or for some equity ISA investments. I don’t yet have a clear view on this. If you enjoy looking at company results and assessing single stock investments it may be for you. If you hate that stuff with a passion it definitely is not and a similar result is easily obtained by buying units in the right kind of equity fund focused in a similar way.
I have not found a good free financial planning template for modelling a 40 year drawdown, inflation, state pension, taxes etc. Excel and roll your own seems to be the way to go. As we all know hell is other people's spreadsheets. As you try and build it you run up against a set of questions which you need a good handle on. My initial research on life beyond annuities led me to look at safe withdrawal rates - back testing and montecarlo analysis on old equity markets of the "how much could I have with a given near zero chance of running out" question but this now feels actually to be the wrong way up. The proposed budget matters more to understand income flexibility which impacts the approach and the available income. That asks a bunch of hard personal questions you need to answer for a scenario to be realistic. Here are the ones I have come up with. Whether you plan your own or talk to an IFA you'll still need a POV on these. Yours will vary.
1 Activity - building a better version of a long term budget – what is really needed as regular income and for "nice to haves" and one offs (discretionary). This can then be used to gain understanding with back testing and peer comparison of how risky a planned indexed withdrawal rate meeting this budget profile will be when viewed against a back test of difficult periods (market corrections, slumps, high CAPE at retirement etc.). From this you can get to be comfortable with the idea of drawdown for your "cohort" (age based in terms of market timing.
2 Property assumptions – developing a scenario for where to be living and when over the next 40 years (Good luck with that) or some assumptions on the capital tied up and cost relative to now.
3 Further assumptions on cars, travel, toys - trains boats planes guitars and topics like helping children and parents and how these discretionary items fit into the base budget
4 Are there any potential inheritance impacts (inward, outgoing, tax assumptions, potential use of deeds of variation etc. which are affected by when these things happen
5 Care - the big one - what assumptions do you make on about care costs. Unknown political changes inbound to socialise this risk (for both good and ill). I suspect I will be asked to pay for this whether I need it or not via new taxes to socialise - which will materially hit the budget and then be means tested as to be ineligible to receive it without further co-payment/cross-subsidy as now. So a shit show – but it pretty much has to work like that to be affordable overall. Or carry on as we are with the various postcode injustices uncapped personal costs and other problems that causes. Not good either.
6 Handling a return of the 1970’s. Understanding EU / Irish / Other contingencies against a full blooded revisiting of that ugly era. Waste it first - consume savings excess and telling the tax man to feck off being a fall back of last resort still available with UK residency and domicile.
7 Check any emerging plan for common sense IHT planning based on today’s rules. This particular tail must not be allowed to wag the overall dog but there is no need to be wantonly stupid about it either.
This is my blog - it's a bit of a mixture - covering IT professional and personal finance topics. On rare occasions I get genuinely excited about a new thing in IT and I may post about it here at length vs a quick snark on linkedin. Partly because so little is genuinely new or of substance and partly because I am not easily moved to great excitement by a new syntax or yet another data access framework.
I'll also be posting about personal finance and my voyage of discovery in my 50's on UK DC pension planning for drawdown. This will keep my facebook timeline cleaner for my mixture of friends who do / do not care about this topic. Compliance health warning - I am not a lawyer, or an IFA so nothing here is in any way financial advice. Do your own research and if anything here helps you find good resources or accelerate that then that's great.
When between contracts - have been planning for accessing rather than saving for DC Pension. This blog section provides a view into my personal research on roughly a quarterly update. Nothing here is financial advice - I am not an IFA. Do your own research. I have been evaluating "how difficult is drawdown" and self management thereof. The answer seems to be manageable but more complex than it needs to be and the investment side is as simple or complex as you let it get. Bureaucracy element awkard and a moving target. Also been discovering and working through the personal questions we all need to answer to build a plan - either alone or with an IFA.
This quarter - I have found the following to be useful sources: Book - Living off your Money (McClung), ERN blog. MoneySavingExpert forum.
Musings on handling sequence of returns risk in early retirement - such as a global market correction of 30%-50% between 2020-2030
For drawdown handling this is about the cash+bond buffering for near term “to be consumed” pot; the approach taken to extraction/flexibility and working out if/how bonds held to maturity fit in a cash buffer. I still lack clarity on bonds to stock correlation and have a general loss aversion to overcome for bond funds in current markets. Holding actual bonds to maturity and a rolling purchase approach for refreshing a ladder seems to mean that repricing vs interest rate risk/expectation not an issue for actual bonds in this buffer usage. Just coupon yield and any locked in losses from initial pricing vs par at redemption. My current challenge is how/when to change mix from 100% equities to avoid mistakes of inaction around a big correction. This is a game of chicken with trade wars, brexit and the complex currency/equity market interaction for sterling.
Local issues to my ex employer scheme
Sadly - I am told you can’t take a PCLS and leave crystallised but not drawn down funds which would have been a wizard wheeze to hold equities for 5-10 years (up to a £30k saving on platform fees). So it's transfer out to a SIPP pre-commencement or PCLS and open market annuity purchase. Can’t PCLS, defer annuity purchase and transfer funds out later. On the plus side TowersWatson say they will transfer out to two SIPPs if I want to hedge platform risk and improve the regulatory level of protection. This is an insurance which is likely to cost ~£1000/pa in incremental SIPP platform fees for double the regulated protection and 50% non-disruption of access to income in the platform failure case. Still moderately expensive over the long haul if you pick someone reputable to start with.
My emerging base case thinking is a cash+bond buffer of between 3 and 5 years this viewed across what’s in the SIPP and accessible elsewhere i.e. small business, cash ISA’s etc.) and the rest in global equities (passively at lowest possible fee drag). Waiting for Vanguard to launch their UK SIPP platform.
This KISS approach - cash buffer plus passive global equities is favoured by Lars Kroijer videos and blog. Videos are basic and repetitive but the challenge is to either accept the logic chain or frame a refutation and base a different strategy thereon. He recommends “hold the whole of the global market” cheaply. Argument is that the individual retail investor knows less than and is time and resource poor vs stock and sector analysts. Implication being you can’t realistically pick regional, sector or stock weightings better or tell which are the 1 in 10 seriously outperforming fund managers ahead of time when looking out over pension timeframes i.e. 40 years. Beating the market thus becomes a crapshoot. Aim to beat 8 out of 10 people through a whole of global market at weight at reduced fee drag. Short of a crash of Japanese lost decade dimensions – you pick your poison on % equity returns foregone vs size of the “insulation” cash+bonds to sustain income after a market correction. Mitigates forced of selling equities low for sequence of returns risk in early retirement to a degree.
However the ERN blog has done some back testing on this buffering and flexibility of income idea which bears further study as it suggests “flexibility” is less than a panacea in the worst back testing periods.
With base case in hand – any IFA recommended, managed options or anything spicier – say at ~20% of pot for a more diversified mix (HighYieldPortfolio stock picking, commodities, emerging markets/tech funds, commercial property etc.) will need a compare vs this base case on a back test net of fees. Anything magical and encapsulated with no easy history to compare will likely get short shrift
In reading this quarter - one interesting or alarming variant that I came across was a recommendation to use leveraged 3x ETF (derivative based) for equities exposure (at around a 25% of pot level) and the rest in a GI bond ladder/self built annuity. Logical in its own terms to ramp back up equity exposure for more discretionary upside and limit downside (to the wipe out of the 25%) but leverage of volatility now makes this 3x more likely. I then read about how (some) of these ETF’s work for margin and daily settlement and learned that buy and hold on these derivatives designed for intraday is likely to be a punishing experience. There is a lot of material out there on the internet all with passionate advocates: some of it dangerous to your financial health. Timely reminder of the old adage of only buying things you actually understand.
UK Political Risks on rollback of pension reforms and guaranteed income
Lots of media coverage on political risk around the stealthy reversal of pension freedom and the FCA consultation on pension flexibility “outcomes”. The research is very small, very early; the weight of evaluation is carried on a small sample. The directional narrative on “protection” of the naïve investor is clear. To “protect” people from no or bad choices via regulation and non-advised default pathways - and to perhaps also restrict non-advised choice. The emphasis around “advised” vs non-advised” has the stench of monopoly rent seeking lobbyists at work. One to watch for collateral damage to anyone planning self-managed.
Another political kite being flown doesn’t reverse pensions freedom as such but does so in practice for the masses. Forced purchase of guaranteed income to a minimum £ level (thus avoiding the terrible if hypothetical risk of destitute DC pensioners who freed up their funds bought ferraris and had them confiscated and crushed by French Plod - falling back on the state). This would remove drawdown freedoms for all but a vanishingly tiny minority with enough “qualifying” guaranteed income sources. Risk timing on this is ~2023 +/- 2. By way of illustration: a mandate to “buy as much as you can afford from your pot but without access to flexibility until you reach £20k guaranteed income”– on current annuity rates that is a ~450k DC pot (single life, level which is not what most want) or a ~675k DC pot (joint 3% indexed, spouse half). At those levels it’s goodbye to drawdown flexibility for most people based on the real world distribution of pot sizes.